Make Your Savings Work Harder

With interest rates falling, Harvey Jones explores the best ways to increase the return on your savings.

If anybody deserves a generous helping of sympathy during the current crisis, it has to be savers.

After resisting the blandishments to borrow, borrow, borrow over the past decade, they now see their virtue being punished by 0% interest rates.

True, they did enjoy a brief respite in the early days of the crunch, as banks rushed to offer fixed-rate bonds at 7% plus, and I hope that many wise Fools out there locked into them.

But with base rates collapsing, only a lucky handful of savers are currently outstripping the (admittedly falling) rate of inflation.

A higher-rate taxpayer now needs to earn 5.17% gross just to keep pace with inflation (3.1% according to the CPI), according to Defaqto, whereas a basic rate taxpayer needs 3.88%.

My various savings accounts and Isas are therefore all shrinking my money, paying 2.99% (Northern Rock Tracker Online), 2.4% (Alliance and Leicester International eSaver) and 2.1% (IF cash Isa). Are yours faring any better?

Saving grace.

Even the best savings accounts fail the tax-and-inflation test. Yorkshire building society's Internet Saver manages to top the best buy online savings account chart by paying a modest 3.75%.

Ing Direct has been promoting its 4% variable rate, but this actually only 2%, plus a 12-month bonus of 1.95% - although at least that bonus is fixed. (Mind you, the fact that this account has a large bonus may actually be a good thing if interest rates fall to 0%, as my fellow writer Szu Ping Chan argues here.)

If you want more, you'll have to fix. ICICI Bank UK is currently paying a fixed rate of 4.65%, if you're prepared to lock your money away for a year. But you have to invest at least £1,000.

Alternatively, Anglo Irish Bank has a string of one, two, three, four and five-year bonds paying around 4%, and the minimum investment is just £500. But given that the bank has just been nationalised by the Irish government, which is itself in financial meltdown, I wouldn't place my money there.

Taxpayers should look to their ISA allowance to boost their returns. Birmingham Midshires offers a one-year fixed-rate Isa paying 4.2%, worth 7% gross to a higher-rate taxpayer or 5.25% to somebody on the basic rate. So I guess that's something.

And it must be better than leaving your money in one of the scores of accounts paying between 1% and zero.

But with rates falling all the time, you must also be careful about switching, because after going to all that trouble, you might find your new rate is suddenly slashed as well.

Isn't there anything better out there?

Card sharps.

There are certainly some bizarre offerings. NatWest offers to boost your savings by up to 2% if you sign up to one of its credit cards, the Savings Accelerator Card.

To get that 2%, you have to spend more than £500 a month on the card, which only makes sense if you ruthlessly clear the lot every month with a direct debit.

Even worse, that 2% booster is applied to NatWest's First Reserve account, which currently pays a measly 0.2%. So the most you will get is 2.2%, by signing up to a card that carries a typical APR of 16.9%.

Now you don't need a degree in applied mathematics to spot that these two figures don't exactly balance out. Avoid.

Corporate bonds.

So what about corporate bonds? Early last year, bond fund managers started crowing that, after three years of misery, conditions were ideal to pile back into the sector.

So I did. Well, not exactly piled, but I did place £2,000 into Invesco Perpetual Monthly Income Plus, which also has a little equity exposure. One year on, my money is worth £1,598.

In November, I heard those siren cries again, and placed £1,000 into Old Mutual Corporate Bond. I'm now the proud owner of £856.

People are talking up corporate bonds once again, claiming that yields now look tempting, with Jupiter Corporate Bond paying 5%, Investec Sterling Bond paying 6% and Invesco Perpetual Corporate Bond 6.5%, and likely defaults already priced in.

But you'll still be taking a punt. As my recent experience shows, these apparently low-risk instruments are anything but. If you want the security of cash, you won't find it in corporate bonds.

A not very nice little Ernie.

Some 23 million people hold Premium Bonds, but you have to wonder why, given that the prize fund has dropped from £114 million to £58 million in a year, the minimum prize has just been halved from £50 to just £25 and the current payout rate is a meagre 1.8% and likely to fall further. Still, I guess there is a slither of a chance that it might make you a millionaire.

Zest for Zopa

If you're willing to lend out your savings to a would-be borrower for at least a year via online marketplace Zopa, you could earn a decent return (average is currently 9.1%). But this strategy is not without risks. Read Two Smart Ways To Get A Better Savings Rate for more information or listen to this podcast with David Kuo and Zopa co-founder Giles Andrews.

Pay it down.

If you have savings and a mortgage, your best course of action may be to use the former to pay down the latter, particularly if your lender hasn't been passing on recent base rate cuts.

Your mortgage rate is almost certainly higher than any savings rate, plus you escape tax, because you are saving interest rather than earning it. (Read Why It's Vital To Overpay Your Mortgage Now for more on this topic.)

Otherwise, it's a grim time for savers. Rates will only start improving when inflation and interest rates pick up, but then inflation (or hyper-inflation, if the Government is too free with its printing presses) isn't your friend either.

Still, at least you can console yourself that you still have money in the bank. Plenty of people only have debts.

Compare savings accounts to find the best rates!